In this article, I would like to discuss what trends are seen in companies with high corporate governance practice evaluations and what relationship there is between corporate governance practices and profitability and valuations of the companies.
Since February 2018, Metrical has evaluated a universe of approximately 1,800 companies using more than 40 evaluation criteria based on publicly available information such as annual securities reports, corporate governance reports, and financial statements, etc. which are updated on a monthly basis. Metrical also divides its corporate governance analysis into Board Practices and Key Actions. This is based on the hypothesis that for value creation, which is the goal of company management, improvements not only in board practices but also in board practices lead to decisions and actions (key actions), which in turn contribute to value creation. In other words, even if the composition of the board of directors and other aspects of board practices are formally put in place, they may not be utilized in management to create value. I believe that improvement of board practices should lead to actual actions and create value, which is what corporate governance improvement should be about. Below I discuss the relationship between the Metrical CG Score, which is evaluated based on this idea, and the companies’ profitability and valuations.
The Metrical universe of 1,819 companies (March 2024) is divided into five groups by Metrical CG score ( over 80%, between 70% and 80%, between 60% and 70%, between 50% and 60%, and under 50%) and analyzed in each criteria. The median Metrical CG score is 61 .32%.
The table below profiles the Metrical universe of 1,819 companies (March 2024), divided into five groups by Metrical CG score (over 80%, between 70% and 80%, between 60% and 70%, between 50% and 60%, and under 50%). As noted above, I believe that a company with good corporate governance practices should create value. However, even though the Metrical CG Score methodology was not designed with the intent of the Metrical CG Score evaluation methodology, there is a noticeable trend that companies with higher Metrical CG Scores tend to have higher profitability, market capitalization, and valuations. As the table below shows, differences in foreign ownership are reflected in the Metrical CG score. This is indicated by the fact that among the profile items, foreign ownership has the highest correlation with the Metrical CG score. This means that overseas investors are very interested in whether corporate governance practices and profitability are improving. Therefore, they look to management to improve corporate governance practices and profitability through engagement. Companies with high Metrical CG scores (i.e., those that implement key actions that actually result in value creation, not just superficial board composition) are the result of such years of activity. Such value creation and investor appreciation are believed to have resulted in increased market capitalization and relatively high valuations.
The table below shows the characteristics of board practices in the five groups of Metrical CG scores. It can be seen that the pace of companies’ efforts varies depending on the Board Practices section. The 2021 revision of the Corporate Governance Code requires prime market listed companies to have at least 1/3 independent directors, to establish nominating and compensation committees (including voluntary committees), and to ensure independence (a majority of committee members must be outside directors and the committee must be chaired by an outside director). As a result, more than 60% of companies with a Metrical CG score have established nominating and compensation committees and ensured their independence. On the other hand, the ratio of independent directors and the ratio of female board members are found to be ahead of companies with Metrical CG scores of over 80% and between 70% and 80%, respectively. Together, these two groups represent 17.2% of all companies and are characterized by a median foreign ownership ratio of 37.15% and 27.60%, respectively. When foreign ownership is in the 30% range, companies tend to incorporate the opinions of overseas investors. This is why these two groups have a median independent director ratio of 50%. They are also ahead of other groups in the ratio of female board members, even though the ratio is still low.
The table below shows the characteristics of the Key Actions in the five groups of Metrical CG Scores. The AGM Disclosures Score is the one that does not differ much among the groups in the Key Actions evaluation criteria. This may be due to the fact that many companies have joined electronic platforms for exercising voting rights, and many companies have begun to send out convocation notices earlier. On the other hand, the IR Disclosures Score shows that the group of companies with the highest foreign ownership in English language disclosure is ahead of the group of companies with a Metrical CG score of 80% or higher. It can also be inferred that this group is better able to balance growth (Growth Policy Score) and shareholder return (Dividend Policy Score, Treasury Stocks Retirement) than the other groups. On the other hand, there is not much difference in Cash Holding Score between this group and the other groups, so this group can return more cash on hand. The Policyshare Holding Score is also higher than that of the other groups, suggesting that they have been strongly requested by overseas investors to reduce their policy shareholdings and have gradually started to implement such a move.
In summary, I have considered what trends are seen in companies with high corporate governance practice evaluations and what relationship there is between corporate governance practices, company profitability, and valuations.
The Metrical universe of 1,819 companies (March 2024) is divided into five groups by Metrical CG score ( more than 80%, 70% to 80%, 60% to 70%, 50% to 60%, and less than 50%) for each item. The median Metrical CG score is 61.32%.
The Metrical universe of 1,819 companies is profiled by Metrical CG score into five groups (80%+, 70%-80%, 60%-70%, 50%-60%, and 50%-50%), companies with higher Metrical CG scores tend to have higher profitability, market capitalization, and valuations.
Since foreign ownership has the highest correlation with the Metrical CG score, overseas investors are very interested in whether corporate governance practices and profitability have improved. As a result of years of engagement by overseas investors, companies with higher foreign ownership are likely to have improved their corporate governance practices and profitability.
The Board Practices items show differences in the pace of the company’s efforts. The establishment and independence of nominating and compensation committees (including voluntary committees) is a requirement for prime market listed companies, so there is no difference among companies with Metrical CG scores of 60% or higher. On the other hand, the ratio of independent directors and the ratio of female board members are ahead of the companies with Metrical CG scores of 80% or higher and those with Metrical CG scores between 70% and 80%. These two groups are working ahead of the others on the back of their high foreign ownership ratios.
Key actions in the five Metrical CG Score groups are also distinctive: the group of companies with a Metrical CG Score of 80% or higher is ahead of the other groups in English language disclosure efforts, due to the highest percentage of foreign ownership. This group of companies also seems to be able to balance growth (Growth Policy Score) and shareholder returns (Dividend Policy Score, Treasury Stocks Retirement) better than the other groups. This may also be due to the engagement of overseas investors.
http://www.metrical.co.jp/cg-ranking-top100/
Aki Matsumoto, CFA
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http://www.metrical.co.jp/
Please feel free to contact the below email address if any interest or query.
Aki Matsumoto, CFA
Executive Director
Metrical Inc.
akimatsumoto@metrical.co.jp
http://www.metrical.co.jp/jp-home/